Don’t scream at me but I would need some help with the term “add-on rate”. It is said that LIBOR is an add-on rate, but I cannot picture it. I know it might sound silly to some of you, and I apologize for the question, but can anyone try to explain it as for a 5-year old kid? Thanks!
So suppose I quote 5% as the add-on yield for a $1M dollar loan for a year. That means that at the end of the year, you are going to pay me $1M + 0.05*1M = $1,050,000. If I sell you T-bills or something at a 5% discount yield on $1M. That means you are paying me $950,000 now and I will give you back $1M in a year. Note that in the first instance I gained 50,000 on my $1M investment. In the second case, you gained $50,000 on a $950K investment. Which means that I screwed myself in my own example but also that the add-on yield would be higher than the discount yield for the same loan.
Thanks Joey. So if I understand correctly: - the add-on yield is the rate used for compounding interest - while discount yield is the one used for discounting (as implied by the name) So in your example: - you made 50K out of 1Mio --> yield of 5% - I made 50K out of 950K --> yield of 5.26% So why do you say that add-on is higher than discount yield? Sorry to insist on that, but as a non native English speaker, I am sure it’s just a question of wording for me. Thanks again for your much appreciated help
nicolargol Wrote: ------------------------------------------------------- > Thanks Joey. > > So if I understand correctly: > > - the add-on yield is the rate used for > compounding interest > - while discount yield is the one used for > discounting (as implied by the name) > > So in your example: > - you made 50K out of 1Mio --> yield of 5% > - I made 50K out of 950K --> yield of 5.26% > > So why do you say that add-on is higher than > discount yield? > Because if I quote you a discount rate of 5%, you should think that the add-on yield is higher than that. But agree that my language was ambiguous. You have this down, it seems. > Sorry to insist on that, but as a non native > English speaker, I am sure it’s just a question of > wording for me. > > Thanks again for your much appreciated help